difference between loss aversion and disposition effect

CFA Level III
#1

Hi guyz…can you help identify what is the difference between loss aversion and disposition effect

#2

Answer below

#3

Wrong comment …

#4

thanks guyz

#5

There is a difference…

The disposition effect is an anomaly discovered in behavioral finance. It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value. This is different from the definition of loss aversion.

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#6

It’s one form of loss aversion.

A loss averse investor can cut losses and let winners run, while another loss averse investor can do the opposite.

The difference between both is risk aversion.

Here is how I see it.

  1. Loss avserse/Risk averse = No disposition

  2. Loss averse/Risk seeking = Disposition

  3. Loss seeking/Risk averse = No disposition

  4. Loss seeking/Risk seeking = Disposition

#7

Loss aversion occurs when people feel more strongly about losses than they feel about gains. Investors sometimes hesitate to realize their losses because of this and hold stocks for too long hoping for a recovery. Now do you see the difference? But then again, what do I know?..

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#8

Loss aversion is a given for investors (I guess it goes under the definition of a rational investor)

The disposition effect occurs when the investor is less risk averse, or more risk seeking. The oppoisite of which is the golden rule behind trading and investing, cut your losses, let the winners run.

#9

My understanding is that loss aversion does not come under the definition of a rational investor - whereas risk aversion does.

Seeing things in terms of gain/loss is a behavioural finance trait, whereas seeing things in terms of risk/reward is rational.

#10

My understanding is that both come under the definition of a rational investor. The difference is loss aversion is the behavioural aspect of reacting to a position, while risk aversion is the tendency to maximize return for a given level of risk.

Expressed in numbers, loss aversion seeks to maximize the sortino ratio, while risk aversion seeks to maximize the sharpe ratio.